Comments of Noah S. Fried, Associate Equity Analyst

Comments on Financial REITs

What types of investments are used by the Financial REITs to earn money for their shareholders?

Financial REITs invest in several types of financial assets, such as mortgage backed securities (MBS), as well as originating mortgages, and some companies engage in raising money for private and public companies and lending through structured financings.

How do you differentiate between the stocks in the Financial REIT group?

I always take a fundamental approach to my analysis, and also contrast the companies by valuation and the composition of their portfolios. Dividend coverage, as well, is very important to the choice of stocks in this group. Not all Financial REITs should be treated equally by investors. In the MBS area, for example, I think the sub-prime market is going to outperform the prime market, as it is not as interest rate sensitive as the prime market. For the structured finance group, interest rate increases are not much of a risk, but credit risk is important, if a borrower were to default on a loan.

Taxable earnings is what drives the dividend for a Financial REIT stock. For GAAP earnings, companies delay the recognition of income, whereas with taxable income, gains are recognized up front. Trends in taxable earnings are the signal for changes in the dividend. (REITs are required to pay out 90% of their taxable earnings as dividends to their shareholders).

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